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GURE > SEC Filings for GURE > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Form 10-K for GULF RESOURCES, INC.


18-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

We are a holding company which conducts operations through our wholly-owned China subsidiaries. Our business is conducted and reported in three segments, namely, bromine, crude salt and chemical products.

Through our wholly-owned subsidiary, SCHC, we produce and trade bromine and crude salt. We are one of the largest producers of bromine in China, as measured by production output. Elemental bromine is used to manufacture a wide variety of bromine compounds used in industry and agriculture. Bromine also is used to form intermediary chemical compounds such as T.M.B. Bromine is commonly used in brominated flame retardants, fumigants, water purification compounds, dyes, medicines and disinfectants. Crude salt is the principal material in alkali production as well as chlorine alkali production and is widely used in the chemical, food & beverage, and other industries.

Through our wholly-owned subsidiary, SYCI, we manufacture and sell chemical products used in oil and gas field exploration, oil and gas distribution, oil field drilling, wastewater processing, papermaking chemical agents and inorganic chemicals.

On December 12, 2006, we acquired, through a share exchange, Upper Class Group Limited, a British Virgin Islands holding corporation which then owned all of the outstanding shares of SCHC. Under accounting principles generally accepted in the United States, the share exchange is considered to be a capital transaction in substance, rather than a business combination. That is, the share exchange is equivalent to the issuance of stock by Upper Class for the net assets of our company, accompanied by a recapitalization, and is accounted for as a change in capital structure. Accordingly, the accounting for the share exchange was identical to that resulting from a reverse acquisition, except no goodwill was recorded. Under reverse takeover accounting, the post reverse acquisition comparative historical financial statements of the legal acquirer, our company, are those of the legal acquiree, Upper Class Group Limited, which is considered to be the accounting acquirer. Share and per share amounts reflected in this report have been retroactively adjusted to reflect the merger.

On February 5, 2007, we, acting through SCHC, acquired SYCI. Since the ownership of Gulf Resources, Inc. and SYCI was then substantially the same, the transaction was accounted for as a transaction between entities under common control, whereby we recognized the assets and liabilities of SYCI at their carrying amounts. Share and per share amounts stated in this report have been retroactively adjusted to reflect the merger.

On August 31, 2008, SYCI completed the construction of a new chemical production line. It passed the examination by Shouguang City Administration of Work Safety and local fire department. This new production line focuses on producing environmental friendly additive products, solid lubricant and polyether lubricant, for use in oil and gas exploration. The line has an annual production capacity of 5,000 tons. Formal production of this chemical production line started on September 15, 2008.

On October 12, 2009 we completed a 1-for-4 reverse stock split of our common stock, such that for each four shares outstanding prior to the stock split there was one share outstanding after the reverse stock split. All shares of common stock referenced in this report have been adjusted to reflect the stock split figures. On October 27, 2009 our shares began trading on the NASDAQ Global Select Market under the ticker symbol "GFRE" and on June 30, 2011 we changed our ticker symbol to "GURE" to better reflection of our corporate name.

As a result of our acquisitions of SCHC and SYCI, our historical financial statements and the information presented below reflects the accounts of SCHC and SYCI. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report.


Table of Contents

RESULTS OF OPERATIONS

Year ended December 31, 2012 as compared to year ended December 31, 2011

                                               Years ended
                                December 31, 2012       December 31, 2011       % Change
Net Revenue                    $       101,700,882     $       164,980,453           (38%)
Cost of Net Revenue            $       (73,439,341 )   $       (89,538,212 )         (18%)
Gross Profit                   $        28,261,541     $        75,442,241           (63%)
Sales, Marketing and Other                                                            (6%)
Operating Expense              $           (82,004 )   $           (86,936 )
Research and Development                                                             (59%)
Costs                          $          (164,586 )   $          (398,842 )
Exploration Costs              $                 -     $        (7,034,153 )        (100%)
Write-off / Impairment on
property, plant and                                                                  (86%)
equipment                      $        (1,042,138 )   $        (7,570,566 )
General and Administrative                                                           (62%)
Expenses                       $        (6,792,110 )   $       (17,874,296 )
Other Operating Income         $           304,152     $         1,821,010           (83%)
Income from Operations         $        20,484,855     $        44,298,458           (54%)
Other Income, Net              $           102,101     $            57,173             79%
Income before Taxes            $        20,586,956     $        44,355,631           (54%)
Income Taxes                   $        (5,591,453 )   $       (13,402,871 )         (58%)
Net Income                     $        14,995,503     $        30,952,760           (52%)

Net Revenue Net revenue for the fiscal year 2012, was $101,700,882, representing a decrease of $63,279,571 or 38% over the same period in 2011. This decrease was primarily attributable to the reduction of overall demand for all of our segment products, specifically, (i) revenue from the bromine segment decreased from $107,849,304 for the fiscal year 2011 to $56,332,785 for the same period in 2012, a decrease of approximately 48%; (ii) revenue from the crude salt segment decreased from $15,918,655 for the fiscal year 2011 to $11,143,848 for the same period in 2012, a decrease of approximately 30%; and (iii) revenue from the chemical products segment decreased from $41,212,494 for the fiscal year 2011 to $34,224,249 for the same period in 2012, a decrease of approximately 17%.

                                                   Net Revenue by Segment                                  2012 vs. 2011
                                     Year Ended                               Year Ended                   Percent Change
                                 December 31, 2012                        December 31, 2011                of Net Revenue
Segment                                    Percent of total                         Percent of total
Bromine                $  56,332,785                  55 %      $ 107,849,304                  63 %               (48 %)
Crude Salt             $  11,143,848                  11 %      $  15,918,655                   9 %               (30 %)
Chemical Products      $  34,224,249                  34 %      $  41,212,494                  28 %               (17 %)
Total sales            $ 101,700,882                 100 %      $ 164,980,453                 100 %               (38 %)



                                                  Years Ended December 31         Percentage Change
Bromine and crude salt segments product sold
in tonnes                                          2012              2011              Decrease
Bromine (excluded volume sold to SYCI)               17,467           26,418               (34 %)
Crude Salt                                          297,206          355,962               (17 %)



                                                  Years Ended December 31           Percentage Change
Chemical products segment sold in tonnes           2012              2011          Increase/(Decrease)
Oil and gas exploration additives                    10,380            15,208                (32 %)
Paper manufacturing additives                         2,819             3,622                (22 %)
Pesticides manufacturing additives                    3,045             2,849                  7 %
Wastewater treatment chemical additives                   -               120                100 %
                                                     16,244            21,799                (26 %)


Table of Contents

Bromine segment
The decrease in net revenue from our bromine segment was mainly due to the decrease in both the sales volume and selling price of bromine. The sales volume of bromine decreased from 26,418 tonnes for the fiscal year 2011 to 17,467 tonnes for the same period in 2012, a decrease of 34%, despite the increase in the number of our bromine production plants in recent years, which maintained our production capacity. As mentioned hereinbefore, the major reason for the decrease in the sales volume of bromine was mainly attributable to the drop in overall demand for bromine as a result of the recent macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy, which has affected our customers' industries.

Due to the drop in demand of bromine, since the second half of 2011, we needed to offer competitive selling prices to our customers to compete with other bromine manufacturers. The average selling price of bromine decreased from $4,082 per tonne for the fiscal year 2011 to $3,225 per tonne for the same period in 2012, a decrease of 21%. The average selling price for the first half of 2012 remained relatively stable at around $3,500 per tonne and further dropped to $2,954 per tonne in the fourth quarter of 2012 in order to retain our major customers. We expect the average selling price of bromine will remain at current levels through the first quarter of 2013 should the PRC government's macro-economic tightening policy remain in place. The table below shows the changes in the average selling price and changes in the sales volume of bromine for the fiscal year 2012 from the same period in 2011.

                                                       Fiscal Year
Decrease in net revenue of bromine as a result of:    2012 vs. 2011
Decrease in average selling price                    $ (18,812,236)
Decrease in sales volume                             $ (32,704,284)
Total effect on net revenue of bromine               $ (51,516,520)

Crude salt segment
The decrease in net revenue from our crude salt segment was mainly due to the decrease in both the average selling price and sales volume of crude salt. The average selling price of crude salt decreased from $44.72 per tonne for the fiscal year 2011 to $37.50 per tonne for the same period in 2012, a decrease of 16%, and the sales volume of crude salt also decreased by 17% from 355,962 tonnes for the fiscal year 2011 to 297,206 tonnes for the same period in 2012. The decrease in both the average selling price and sales volume was a result of the macro-economic tightening policy imposed by the PRC government beginning in the second half of 2011 to slow down the economy. This policy resulted in, among other things, the decrease in the demand for crude salt for downstream production of chlorine alkali and use in chemical, food and beverage industries. The table below shows the changes in the average selling price and changes in the sales volume of crude salt for the fiscal year 2012 from the same period in 2011.

                                                          Fiscal Year
Decrease in net revenue of crude salt as a result of:    2012 vs. 2011
Decrease in average selling price                       $  (2,359,477 )
Decrease in sales volume                                $  (2,415,329 )
Total effect on net revenue of crude salt               $  (4,774,806 )

We noted a downward trend in the average selling price of crude salt since the first quarter of 2011 as we offered competitive selling prices to our customers in order to compete with other crude salt manufacturers. The average selling price decreased sharply from $50.09 per tonne in the first quarter of 2011 to $37.19 per tonne in the third quarter of 2011 and then maintained at a relatively stable price levels at $37 per tonne through the fourth quarter of 2012. We expect the average selling price of crude salt will remain at current levels through the first quarter of 2013 should the PRC government's macro-economic tightening policy remain in place.


Table of Contents

Chemical products segment

                                                               Product Mix of Chemical Product Segment                             2012 vs. 2011
                                                       Year Ended                                    Year Ended                    Percent Change
                                                    December 31, 2012                            December 31, 2011                 of Net Revenue
Chemical Products                                              Percent of total                            Percent of total
Oil and gas exploration additives         $  18,721,374                    55 %       $  26,234,497                    64 %                    (29 %)
Paper manufacturing additives             $   3,317,077                    10 %       $   4,762,221                    12 %                    (30 %)
Pesticides manufacturing additives        $  12,185,799                    35 %       $   9,679,768                    23 %                     26 %
Wastewater treatment chemical products                -                     -               536,008                     1 %                   (100 %)
Total sales                               $  34,224,249                   100 %       $  41,212,494                   100 %                    (17 %)

Net revenue from our chemical products segment decreased from $41,212,494 for the fiscal year 2011 to $34,224,249 for the same period in 2012, a decrease of approximately 17%. The decrease was mainly attributable to the drop in demand for our oil and gas exploration additives and paper manufacturing additives. Our oil and gas exploration chemicals are the most popular products within the chemical products segment, which contributed $18,721,374 (or 55%) and $26,234,497 (or 64%) of the segment revenue for the fiscal year 2012 and 2011, respectively, with a decrease of $7,513,124, or 29%. Net revenue from our paper manufacturing additives decreased from $4,762,221 for the fiscal year 2011 to $3,317,077 for the same period in 2012, a decrease of approximately 30%. We believe that as result of the recent macro-economic tightening policy imposed by the PRC government to slow down the economy, the overall demand for chemical products was reduced, which resulted in a decrease in our volume of both oil and gas exploration additives and paper manufacturing additives sold, which decreased by 32% and 22%, respectively, for the fiscal year 2012 as compared with the same period in 2011. Also, in June 2011 we stopped the production of our wastewater treatment chemical additives due to the profit margin lower than estimated by the management.

However, the effect of the decrease in net revenue from our chemical products segment was partially offset by the increase in the average selling price of our pesticides manufacturing additives products due to the strong demand for such products. The average selling price per tonne for our pesticides manufacturing additives increased by 18% for the fiscal year 2012 as compared with the same period in 2011. The PRC government continued to support expansion of agricultural related products, which supported the growth in sales of our pesticides manufacturing additives. Also, we successfully converted the production equipment from wastewater treatment chemical additive to pharmaceutical and agricultural chemical additives, which contributed higher profit margins as compared to other chemical products.

The table below shows the changes in the average selling price and sales volume of major chemical products (wastewater treatment chemical additives excluded) for the fiscal year 2012 as compared to the same period in 2011.

Increase / (Decrease) in net
revenue of major chemical                                       Paper            Pesticides
products, for fiscal year 2012          Oil and Gas         Manufacturing       Agricultural
vs. 2011, as a result of:          Exploration Additives      Additives           Additives           Total
Increase / (Decrease) in average                                                                  $  2,339,421
selling price                      $    1,004,880          $    (444,811)     $   1,779,352
Increase / (Decrease) in sales                                                                    $ (8,791,658 )
volume                             $   (8,518,003 )        $   (1,000,333 )   $     726,678
Total effect on net revenue of                                                                    $ (6,452,237 )
chemical products                  $   (7,513,123 )        $   (1,445,144 )   $   2,506,030



Cost of Net Revenue

                                                   Cost of Net Revenue by Segment                               % Change
                                         Year Ended                              Year Ended                    of Cost of
                                      December 31, 2012                       December 31, 2011               Net Revenue
Segment                                        Percent of total                        Percent of total
Bromine                     $ 41,794,181                  57 %      $ 56,468,761                  61 %                (26 %)
Crude Salt                  $  7,174,436                  10 %      $  4,776,283                   4 %                 50 %
Chemical Products           $ 24,470,724                  33 %      $ 28,293,168                  35 %                (14 %)
Total Cost of Net Revenue   $ 73,439,341                 100 %      $ 89,538,212                 100 %                (18 %)


Table of Contents

Cost of net revenue reflects mainly the raw materials consumed and the direct salaries and benefits of staff engaged in the production process, electricity, depreciation and amortization of manufacturing plant and machinery and other manufacturing costs. Our cost of net revenue was $73,439,341 for fiscal year 2012, a decrease of $16,098,871 (or approximately 18%) compared to fiscal year 2011. The decrease in overall cost of net revenue was mainly attributable to the decrease in volume of raw materials purchased as a result of the decrease in volume of products sold in fiscal year 2012, as compared to fiscal year 2011, which was partially offset by the increase in depreciation and amortization of manufacturing plant and machinery and increase in purchase price of raw materials.

Bromine production capacity and utilization of our factories

The table below represents the annual capacity and utilization ratios for all of our bromine producing properties:

                                             Annual Production
                                               Capacity (in        Utilization
                                                  tonnes)          Ratio (ii)
Fiscal year 2011                                  41,547  (i)             67%
Fiscal year 2012                                  44,547                  42%
Variance of the fiscal year 2012 and 2011          3,000  (iii)          (25% )

(i) Annual production capacity for the fiscal year was adjusted with the appraisal report carried out by an international appraisal firm, Grant Sherman Appraisal Limited, in October 2011.

(ii) Utilization ratio is calculated based on the annualized actual production volume in tonnes for the periods divided by the annual production capacity in tonnes.

(iii) The increase in 3,000 tonnes production capacity represents the management's estimated capacity of Factory No. 10 acquired in late December 2011.

Our utilization ratio decreased by 25% for the fiscal year 2012 as compared with the same period in 2011. The decrease in utilization was mainly attributable to the drop in overall demand for bromine as a result of the macro-economic tightening policy imposed by the PRC government to slow down the economy, which reduced our sales and production volume since mid-2011.

In view of the trend of a decrease in the bromine concentration of the brine water being extracted at our production facilities, and in order to reduce the leakage rate and attempt to recover the annual production capacity of bromine and crude salt to a higher level in the future, we decided to carry out large scale enhancement work to replace all the eroded protective shells within a four year timeframe, which commenced in the second quarter of 2011. From June through August 2012, we resumed and completed the second phase enhancement works to our existing bromine extraction and crude salt production facilities. The total cost of the second phase enhancement work to the extraction wells and protective shells to transmission channels and ducts in Factories No. 1 to 9 are approximately $12,786,791 and $8,125,659, respectively, which are capitalized as building and plant and machinery. We will temporarily stop the third and fourth phase enhancement for Factories No.1 - No.9 to the extraction wells and protective shells for transmission channels and ducts, but will focus on enhancement on protective shells for transmission channels and ducts for Factories No.10 and No.11, which were acquired in December 2011 and November 2012 respectively, in order to improve the operation efficiency at estimated costs of $10 million in 2013. We estimated that the amount of ordinary repair and maintenance expense will be approximately $2 million in 2013.

Bromine segment

For the fiscal year 2012, the cost of net revenue for our bromine segment was $41,794,181, a decrease of $14,674,580 (or 26%) compared to $56,468,761 for the fiscal year 2011. The most significant components of our cost of net revenue for the bromine segment were cost of raw materials and finished goods consumed of $20,095,456 (or 48%), depreciation and amortization of manufacturing plant and machinery of $13,871,574 (or 33%) and electricity of $2,772,043 (or 7%) for fiscal year 2012. The most significant components of our cost of net revenue for the bromine segment for fiscal year 2011 were cost of raw materials and finished goods consumed of $34,844,710 (or 62%), depreciation and amortization of manufacturing plant and machinery of $10,786,076 (or 19%) and electricity of $4,198,738 (or 7%), a similar cost structure as compared with the same in 2012. The decrease in net cost of net revenue was attributable mainly to the decrease in raw material prices, which is partly offset by the increase in depreciation and amortization of manufacturing plant and machinery. The table below represents the major production cost component of bromine per ton for respective periods:

                                    Year Ended                              Year Ended
                                 December 31, 2012                       December 31, 2011                % Change
                                          Percent of total                        Percent of total
Raw materials          $     1,150                   48 %      $     1,319                   62 %              (13 %)
Depreciation and
amortization           $       794                   33 %      $       408                   19 %               95 %
Electricity            $       159                    7 %      $       159                    7 %                0 %
Others                 $       289                   12 %      $       252                   12 %               15 %
Production cost of
bromine per ton        $     2,393                  100 %      $     2,138                  100 %               12 %


Table of Contents

Our production cost of bromine per tonne was $2,393 for the fiscal year 2012, an increase of 12% (or $255) over the same period in 2011, which was attributable mainly to the component of depreciation and amortization of manufacturing plant and machinery. The significant percentage increase in depreciation and amortization per tonne by 95% was due to (i) the enhancement projects since June 2011 to our extraction wells and transmission channels and ducts, together with the change in the estimated useful life of certain protective shell and transmission channels and ducts from 8 years to 5 years in June 2011, which accelerated the depreciation and amortization of the plant and machinery; (ii) the lower volume of bromine produced as a result of the decrease in demand, which increased the per tonne share of depreciation and amortization of the plant and machinery; and (iii) the second phase enhancement projects in second quarter of 2012 to our extraction wells and transmission channels and ducts, together with the construction of new Factory No. 4 in November 2011 and acquisition of Factory No. 10 in December 2011, which increased the depreciation and amortization of the plant and machinery. The cost of raw materials consumed per tonne decreased by 13% in fiscal year 2012 as compared to fiscal year 2011, which was mainly attributable to the decrease in the purchase price of raw materials due to the macro-economic tightening policy imposed by the PRC government. Since January 2011, included in our other production cost was a price adjustment fund, a levy charged by the PRC government, of RMB200 (approximately $32) per tonne.


Table of Contents

Crude salt segment

For the fiscal year 2012, the cost of net revenue for our crude salt segment was $7,174,436, representing an increase of $2,398,153, or 50%, over the same period in 2011. The increase in cost was mainly due to the increase in the number of crude salt fields and enhancement projects performed in late June 2011, acquisition of Factory No. 10 in December 2011 and the second phase enhancement projects which commenced in June 2012 and were completed in August 2012, which in turn increased the depreciation and amortization of manufacturing plant and machinery. The significant costs were depreciation and amortization of $4,850,334 (or 68%), resource tax calculated based on the crude salt sold of $941,873 (or 13%) and electricity of $490,472 (or 7%) for the fiscal year 2012. The significant costs were depreciation and amortization of $2,546,780 (or 53%), resource tax calculated based on the crude salt sold of $935,333 (or 20%) and electricity of $501,005 (or 10%) for the fiscal year 2011. The table below represents the major production cost component of crude salt per ton for respective periods:

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